CWS Market Review – June 3, 2011

I’ve gone up to the great state of Maine for a few days of R&R so this will be an abbreviated edition of CWS Market Review.

Unfortunately, Wall Street decided to use my vacation time for a period of high drama. No need to panic—I’ll fill you in on the latest and I’ll tell you why Wall Street is being its usual melodramatic self.

The big news, of course, is that the S&P 500 dropped 2.28% on Wednesday followed by another 0.14% fall on Thursday. Wednesday’s sell-off was the market’s biggest one-day plunge since August 11th. As you might have guessed, cyclical stocks were the biggest losers on Wednesday; the Morgan Stanley Cyclical Index(^CYC) shed more than 3.5%.

As dramatic as the market drop sounds, the S&P 500 is still well within the trading range that I mentioned in last week’s issue of CWS Market Review. The S&P 500 has now closed between 1,305.14 and 1,348.65 for 42 of the last 48 days. So far, all we can say is that we moved from the top of the range to the bottom—in a very short period of time.

The reason for the market’s bout of irritability seems to be a batch of poor economic news. What surprised me the most was Wednesday’s report on the ISM Index. Let me back up and explain what this is. On the first business day of each month, the Institute for Supply Management reports its manufacturing index for the month that just ended. Any reading above 50 means the economy is growing while any report below 50 means the economy is receding.

Unlike many economic reports, I like ISM report. One reason is that it comes out quickly so there isn’t much time lag. Also, the report isn’t subject to countless revisions like the GDP report. Most importantly, the ISM report has a very good track record of telling us if we’re in a recession or not. Basically, whenever the ISM falls below 45, there’s a very good chance that the economy is in a recession.

Until this latest report, the ISM had been putting up some impressive numbers: four straight months over 60 and 21 straight months over 50. In fact, the March ISM clocked in at 61.4 which was a tie for the highest level since 1983. So it was a bit of a shock on Wednesday when the ISM for May came in at 53.5. That was well below Wall Street’s consensus of estimate 57.1.

Still, I think the bears are overreacting on this one and this reminds me of the Great Double Dip Hysteria of last summer. First, the ISM still came in above 50 (and for the 22nd month in a row) so the economy is growing, but perhaps not as quickly. Also, the stock market should have limited downside risk since valuations are already fairly cheap. Furthermore, this isn’t news to anyone who has been following the earnings trend. The economy is still growing, but the easy gains have faded. That’s a very different story from a recession.

Here’s what’s going on in the stock market: The only thing that’s more dangerous than an investing thesis that’s dead wrong is one that’s partially right. The bears have been pushing hard the message that the economy is weak and stocks are vulnerable. They’re right, but it’s only true for most cyclical stocks and a few hi-fliers. Yes, anyone who bought LinkedIn ($LNKD) at $120 isn’t looking so smart right now. (I don’t think the buyers at $80 look much smarter.) The cyclical stocks are weak and they’re going to lag the market for some time to come. I strongly encourage investors to lighten up on cyclical stocks and long-term bonds. Defensive stocks and the high-quality stocks on our Buy List continue to offer investors very good values.

The biggest side effect of Wednesday’s bloodletting was that bonds have entered the danger zone. The yield on the 10-year Treasury recently dipped below 3% for the first time this year. That’s a P/E Ratio of 33 for an asset that’s not growing its earnings at all. That should tell you how scared investors are. Going by Thursday’s closing price, Johnson & Johnson ($JNJ) yields 3.43% which is 40 basis points more than the 10-year T-bond. That makes zero sense to me.

Turning to our Buy List, the big news this week was the market giving shares of Joseph A. Banks Clothiers ($JOSB) a super-atomic wedgie after its earnings report. The company reported earnings of 64 cents per share which was one penny below Wall Street’s expectations. This is particularly frustrating for me because it’s precisely what I told you to expect. Nevertheless, the bears took this one item of bad news and pounded shares of JOSB for a 13.3% loss on Wednesday.

I apologize for the rattling but when an angry mob is out for blood, they won’t listen to reason. There are a lot of folks out there who simply don’t like JOSB. The stock has risen very quickly this year. In fact, it’s still our #2 performing stock for the year. I had also cautioned investors not to chase JOSB and to let the stock come to you. Well…it’s here. I think Joey Banks is an excellent buy below $50 per share.

There are so many good buys right now on the Buy List. For now, I’ll highlight three. First, AFLAC ($AFL) is very cheap below $47 per share. Abbott Labs ($ABT) now yields 3.75%. Earlier this year, Abbott said it was expecting full-year earnings of $4.54 to $4.64 per share. ABT is an excellent buy below $52. JPMorgan Chase ($JPM) is also looking very good. Jamie Dimon recently said that the company is buying back shares faster than they originally indicated. I’d prefer to see higher dividends, but the bank is currently constrained by the Fed over how much it can raise its dividend. JPM is a good buy any time the stock is below $44 per share.

That’s all for now. I’ll be heading back to the office on Tuesday. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.